Is the world heading for a third oil crisis?

As the price of Brent crude breaks through $34 to hit another 10-year high, all eyes are on Opec's next move
Click to follow
The Independent Online

Bill Clinton yesterday warned the high oil price could trigger a recession in the roaring US economy.

Bill Clinton yesterday warned the high oil price could trigger a recession in the roaring US economy.

The US president, who held talks with Saudi Arabia's Crown Prince Abdullah at the UN Millennium Summit, appealed to the Saudis to help bring down the price.

According to market rumours yesterday, the Saudis have already persuaded the powerful oil cartel, the Organisation for Petroleum Exporting Countries, to increase output by 700,000 barrels a day at their crucial meeting on Sunday.

But analysts are worried that Opec's action will be too little, too late, to prevent the price surging back to levels not seen since the first major oil crisis of 1973 - Opec's heyday - something that could make Mr Clinton's warning a reality.

The president was speaking as the price of Brent crude for delivery next month broke through $34 a barrel to hit $34.50, its highest for 10 years.

Opec is celebrating the 40th anniversary of its founding in Baghdad on 10 September, 1960. It is an opportunity to show that the cartel is still a world power. But for the world's major oil consumers, there is little cause for celebration. The question on many lips is whether the world is on the brink of a third oil shock.

An oil price of $40 - a ludicrous proposition even a few weeks ago - is now being considered seriously. There are other danger signals - stocks are historically low and a synchronised recovery by the world's major economies heralds a massive rise in demand. Meanwhile Opec, which controls about 40 per cent of the world's supply, is sticking to a complex agreement to limit the amount of extra crude its members can add to global supplies.

For students of the oil market, there is a strong feeling of déjà vu. In 1973 and 1979, the world economy suffered an oil shock - a massive increase in the price leading to a sharp slowdown in growth. According to Philip Verleger, a leading American oil analyst, there were three ingredients that contributed to the shock: a disruption in oil supplies at the same time as the global economy enjoyed a strong period of growth; global oil production close to its full capacity and falling investment in oil and gas exploration projects.

This analysis clearly applies today. Since December 1998 when the oil price fell below $10, Opec kept a tight grip on production levels. The ploy worked and in March this year the price rose above $30 for the first time in a decade.

International Energy Agency estimates show Opec's 11 members operating at 75-90 per cent capacity but demand for oil is growing, led by the strength of the US record-breaking economy. Lastly, oil companies cut investment as their share prices fell during "dot.com" mania.

"The world may be entering the third oil crisis," said Mr Verleger, in an article for the Institute of International Economics. "A crisis similar to the disruptions of 1973 and 1979 could be months away," he said.

Seen through Western eyes, the issue is clear. Opec pushed up prices to an artificial and unsustainable level. The solution, therefore, is for Opec to increase output. The cartel attempted to meet the West's demands half-way. In March it increased production and sanctioned a second increase in the summer. At the same time it put in place a complex mechanism to keep oil within a band of $22 to $28. This would trigger a 500,000 barrels-a-day increase on Sunday.

Lawrence Eagles, an analyst at commodity brokers GNI, said Opec would sanction 700,000 barrels a day - or 3 per cent to 25.4 million barrels - to show it was prepared to acknowledge western concerns. He said this would lead to a temporary price fall but was not enough to take it below $30. "Technically the only real resistance on the upside is the Gulf War high of $40.95," he said. "This is still a long way off, but fewer traders are dismissing it as a possibility now, whereas it seemed ludicrous a few weeks ago."

Opec blames the West for raising consumer taxes, new environmental laws in the US, and market speculation for the surge in the price. One retired oil company manager agreed, saying the price had been kept artificially high by market players with a vested interest in a high price. "It is all to do with young turks on bonuses playing games with the price," he said. "It is nothing to do with Opec."

The issue is whether the oil price will lead to a recession. According to Mr Verleger the impact would be much less than in the past. Inflation means that 1973's peak of $40 a barrel oil is the equivalent of as much as $160 now. "Oil prices matter to the world economy. However, the degree of importance has been moderated by the growth in the economy," he said.

There are also signs the West's oil industry is reacting to the crisis. Shell is spending $1.2bn next year to exploit small oilfields in the North Sea while BP says technology is now available to exploit a 4 billion barrel oilfield discovered 23 years ago.

Comments